Tiger Economies Are Roaring Again
The fast growing countries of South East Asia are sometimes referred to as the Tiger economies and recent events have given added weight to this description. Investors have been voting with their feet, pushing-up some international equity markets strongly. In particular, emerging equity markets are striding forward with equities in South Korea, Australia, India, Mexico and Russia hitting all-time record highs and markets in Japan, Hong Kong & Malaysia reaching 4 or 5 year highs. Chinese equities remain depressed but are having a better third quarter.
A key factor driving the Tigers is the real prospect, at last, of a sound economic recovery in Japan. This is a positive for the Asian region as Japan could provide a new engine for Asian export growth. The US is also a large export market and a more robust outlook for the US economy has helped investor sentiment. In addition, Asian equity markets have reacted favourably to the Chinese currency revaluation.
The FTSE All-World Emerging index is up 8% (since June) and 14% (2005 to date) in dollars and the FTSE Pacific ex-Japan index is up 8% in dollars for the year to date. Emerging markets are regarded as cyclical markets by overseas investors and yet despite increasing US interest rates, equity markets in South Korea, India, Russia, Australia and Mexico have all recently hit all-time record highs. So far in 2005, equities in South Korea have risen by 22%, India +16%, Russia +40%, Mexico +13% and Australia +8%.
In general, it is the outlook for underlying corporate earnings in those individual countries that have driven these performances but there appear to be three macro factors which have given these markets a boost in the third quarter.
These include the prospect of a sound economic recovery in Japan, the Chinese currency revaluation and a more robust economic performance from the US. For the economies of South East Asia, apart from domestic growth, export growth to the US, China and Japan are important drivers.
In our opinion, the most significant new factor is the potential recovery in the Japanese economy. The economies of Australia, Thailand, China and Malaysia are all significant suppliers to Japan which is the second largest economy in the world. In total, Asian exports to Japan rose by 16% in the first half of 2005.
After a long period of structural change, Japan is almost uniquely placed among the major economies to benefit from the combined expansion of consumer spending, capital investment and exports. The consumer is expected to be the strongest element driving forward GDP because unemployment has declined to 4.2% from 5% a year ago and wages are now rising.
Better consumer demand and the prospect of inflation alone improve the outlook for Japanese equities. Once confidence improves and Japan loses its deflationary mindset that should give the economy a real boost.
Capital investment as measured by machinery orders showed a better than expected 11% growth in June. Corporate profitability has already shown good progress on the back of restructuring and a further improvement is expected over the next year. As a result, corporate balance sheets are stronger though this has yet to manifest itself as a return of cash to shareholders.
For the year to March 2006, the consensus GDP forecast is for growth of about 1.7%. Risks to the recovery scenario are from significantly higher interest rates in the future but the Bank of Japan is expected to continue to keep its “quantitative monetary easing policy” until inflation appears. A general election has been called for 11th September but this could be a positive development because the prime minister, Koizumi, could be returned with an even stronger reform mandate.
Even Chinese equities have shown a recovery in the third quarter and are up some 8% though they remain down 7% for the year. At the end of July, the Chinese authorities surprised financial markets by announcing a modest revaluation of the Chinese currency. The currency appreciated by 2.1% from Rm8.28 to Rm8.11. The central bank’s chief said it was an “initial” step and it is widely expected that the Chinese currency will strengthen further over the next year but any further changes are likely to be small and gradual. In the longer term, if the currency rises by 25%, it could have the potential to mitigate some of the global imbalances.
The other positive development for Asian/Emerging markets has been the robust economic performance from the US economy and some Q3 GDP forecasts appear to have been revised up. Furthermore, technology exports which account for a significant proportion of exports from South Korea, Taiwan and Singapore should benefit. Global purchasing manager’s indices appear to indicate the end of the soft patch and destocking.
In summary, South East Asian and Emerging equity markets have moved decisively forward over the summer months. Even if the US economy slows in 2006, there is a strong possibility of sustained economic growth in the Asian economies not only due to domestic growth but also on the back of real expansion in Japan, the world’s second largest economy. In the longer term, the revaluation of the Chinese currency could lead to more positive developments for world equities.
By Tony Shepard, analyst at Charles Stanley Equity Research
